Principles of Macroeconomics

Chapter 8: Money and Banking

We will identify and explain the errors in chapter 8: Money and Banking from "Principles Of Macroeconomics" authored by Sayre and Morris. We will number the errors for reference purposes.

The errors in this textbook are by no means an exception. In 2013 I visited the UBC Koerner Library in Vancouver and checked approx. 40 different macroeconomic textbooks and all of them had some version of the money multiplier model.

1. Page 260: section 8.2: What Constitutes Money?

In the second paragraph ( "In the next chapter, we will see that the Bank of Canada needs to control the supply of money to the economy") The Bank of Canada indirectly controls the money supply by setting the overnight lending rate (policy rate), which is what commercial banks charge each other for overnight loans, which affects all other interest rates. Higher interest rates generally mean less money available for the economy and vice versa. The Bank of Canada is also the sole distributor of new currency (bank notes) and it only does it at the behest of commercial banks.

2. Page 263: The Canadian Banking System

In the second paragraph while acknowledging the Bank Act does not specify how much commercial banks need to hold in reserve, it states that they still maintain a target reserve ratio it should read a desired cash reserve ratio. Commercial banks only hold as much cash as they think they need for their day to day business.

In compliance with the 1991 Bank Act, the statutory requirement on chartered banks to hold reserves against certain of their deposit liabilities was reduced to zero in July 1994. Which means commercial banks are no longer required to hold any reserves against customer deposits. In fact if you look at balance sheets of any of the chartered banks you won't find any reference to a reserve account.

3. Page 264:

Last paragraph implies that we survived the financial crises of 2007-2008 relatively unscathed because our banking regulations did not allow extreme risk taking as compared to elsewhere in the world, which is false. This was a talking point with Stephen Harper our then prime minister and Jim Flaherty our then minister of Finance. At the same time that they were bragging about how sound our financial system was Canadian banks were being bailed out to the tune of 114 billion dollars between 2008 and 2010. The government was very careful in calling it "liquidity support" rather than a bailout.

Read the report "The Big Banks' Big Secret" , published in 2012 by the CCPA (Canadian Centre for Policy Alternatives) authored by David MacDonald senior economist.

I found the content and format of the book to be good except for "Money and Banking"

Video

David MacDonald from the Canadian Centre for Policy Alternatives (CCPA) published a report entitled "Big Bank's Big Secret" in 2012 explains banks bailouts following the 2008 financial crisis received almost no media attention or follow up.

Learning Objective 3 asks you to explain how a small amount of cash can support many loans and create more money.

The creation of digital money is not dependent on the amount of cash a bank has on hand.

5. Page 265: Balance sheet of Saymor Bank Ltd.

This fictitious example is meant to simplify and replicate the balance sheet of a commercial bank and does a pretty good job except one thing. You probably already know what that is by now, there are no listed reserve accounts however the term can be used interchangeably with whatever a bank chooses to call its cash balance. In the case of the CIBC you would see cash and deposits with banks, and this has no bearing on how much digital money a bank can create.

6. Page 266 - 270: The Money Multiplier

Those with this textbook or any other Macroeconomic textbook will most likely have an explanation of how the money multiplier theoretically works so I will not include any excerpts here. Again, this is not how the money creation process currently works.

The Money Multiplier Fact or Fiction?

Prior to July of 1994 there were reserve requirements meaning that commercial banks were required to hold a certain percentage of reserves relative to the amount of liability deposits which is consistent with the money multiplier model in the textbook.

However, empirical research initiated by Basil Moore (Moore 1979, 1983, 1988a, 1997, 2001) and later independently corroborated by numerous researchers, including Kydland and Prescott (1990), confirmed a simple operational observation about how banks actually operate, made in the very early days of the monetarist controversy, by the then senior vice-president of the New York Federal Reserve, Alan Holmes. The ‘Money Multiplier’ model assumes that banks need excess reserves before they can make loans. The model process is that first deposits are made, creating excess reserves, and then these excess reserves allow loans to be made, which create more deposits. Each new loan reduces the level of excess reserves, and the process stops when this excess has fallen to zero.

deposits. If the level of loans and deposits then means that banks have insufficient reserves, then

they get them afterwards – and they have a two-week period in which to do so.

In contrast to the Money Multiplier fantasy of bank managers who are unable to lend until they receive more deposits, the real-world practicality of banking was that the time delay between deposits and reserves meant that the direction of causation flowed, not from reserves to loans, but from loans to reserves.

In the circular flow of income the textbook implies that savings are necessary for investment to the business sector, this is only true when speaking about capital investment or when people pool money in a fund and then invest. However commercial banks do not lend out savings they create brand new digital money in the process of making a loan (refer money myth #1).

8. Page 280:

The supply of money excluding cash (which is less than 2.4% of money in circulation today, the rest is digital) is not determined by the Bank of Canada. The money supply or credit is determined by a commercial banks willingness to create the money and a borrower willing to accept the loan. To better understand how money is leveraged up see: http://www.osfi-bsif.gc.ca/Eng/fi-if/rg-ro/gdn-ort/gl-ld/Pages/CAR18_index.aspx , or go to: Videos Jan. 19, 2019 Update.

9. Page 281:

The Bank of Canada does not set the money supply and it is dependent on interest rates, the opposite of what is claimed in the textbook. Basically the higher the interest rates the less people will want to take on new debt and more likely they will want to resolve existing debts, hence a shrinking money supply. The lower the interest rates creates a reversal of the process.